Filing for Bankruptcy May Stave Off Disaster

Chapter 7

Twice as many Americans filed for Chapter 7 bankruptcy as for Chapter 13 during the 12 months through June. Chapter 7 bankruptcy is popular because it wipes out consumer debt, with the exception of some types such as mortgages, alimony payments and certain taxes. During the process of Chapter 7 bankruptcy, all non-exempt property is sold and the proceeds go toward paying creditors. (What property is exempt in bankruptcy proceedings varies from state to state, but often includes some furniture and personal items.) The remaining balances of the forgivable debts are wiped clean and the consumer has a chance to start over.

Chapter 13

Chapter 13 bankruptcy is also called reorganization bankruptcy since debts are organized into a three- to five-year payment plan arranged through bankruptcy courts. The payment plan provides greater flexibility for catch-up payments on a mortgage or car loan, and doesn't involve selling property to pay creditors. Nevertheless, the courts can require some selling of property unless you can prove you can afford the payment plan.

The effect on credit

A bankruptcy won't automatically have the devastating effect on your credit that many consumers fear. While a bankruptcy will remain on your report longer than other entries such as credit cards or car loans -- 10 years compared with the standard seven -- most consumers can still borrow money, just not at preferred rates. (NACBA's Sommer does mention, however, that stricter lending requirements caused by the ongoing credit crisis may put even less-preferred rates out of reach of consumers with bankruptcies on their credit histories.) And a credit score already battered by late payments and defaults in the lead-up to bankruptcy won't necessarily drop lower after bankruptcy.